Startup valuations, deal size to suffer for next 3 quarters: Duff and Phelps
The same deals can happen with a much reduced allocation of capital from private equity and venture capital fundsThe ongoing covid-19 pandemic has negatively impacted deal flow, with not many investments taking place
With startups trying to cope with the impact of covid-19, investors are expected to factor in risk premiums and re-evaluate valuation of ongoing deals, according to a report by management consultancy Duff & Phelps.
As a result, the same deals can happen with a much reduced allocation of capital from private equity (PE) and venture capital (VC) funds, the report said.
“With covid-19 causing severe disruption in business operations, many Indian businesses have seen a major portion of their revenue streams erode rapidly. Without clarity on when these revenues and growth patterns will revive, risk premiums are expected to go up significantly, warranting a re-evaluation of valuation multiples," it said.
For the next three quarters, there might be down-rounds expected for various consumer internet startups, particularly in travel, tourism, entertainment and offline (or hyperlocal) merchandising—most impacted, as individuals continue to stay indoors.
The ongoing covid-19 pandemic has also negatively impacted deal flow, with not many investments taking place. Another reason for the decline in funding activity is down-round protection rights which investors might be executing, making it harder for startups to negotiate deals. A down-round is when a startup raises funds at a lower valuation than its previously ascribed value, as per its last fundraise.
“With valuations of businesses falling, some investors might be exercising their down-round protection rights, which saves their investment value in the startup from declining. This means that stakes of other investors on the cap table will reduce, which they won’t be comfortable with. And these negotiations between startups and investors might take it longer for deals to close," said Santosh N., managing partner, Duff and Phelps India Advisory LLP.
Valuations are also expected to drop by almost 40% for startups severely impacted by the ongoing pandemic. And for those with certain revenue lines impacted, there wouldn’t be a net increase in valuations during the current times.
The report adds that VC and PE funds currently are focused on helping their portfolio companies by way of additional equity infusions, bridge financing, and providing additional bandwidth to their portfolio company management teams that are currently firefighting on multiple fronts.
For new investments, Duff & Phelps expect that most funds will wait for more clarity. Startups may find it more difficult to raise future rounds from investors and may see some consolidation among the various PE/ VC portfolio companies to bring in efficiencies.
On the contrary, the covid-19 pandemic has also caused a positive outlook for several sectors including technology, essential consumer goods and healthtech startups along with companies focusing on productivity solutions, logistics, delivery, edtech, and online entertainment, the report adds.
Interestingly, according to Santosh, investors continue to be bullish about these sectors and are even willing to back the second or third largest startup in the segment.
“With VC and PE funds unable to back market leaders, owing to the quantum of investments required, investors have started to look at the next line of competitors for investments. We have also seen examples where valuation of companies in segments like Edtech rise by almost 40%, which weren’t even market leaders," added Santosh.
Investments in these segments are largely to fund newer business divisions or for inorganic growth through acquisitions of smaller technology players.
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